What is a business overdraft facility?
A business overdraft is a form of commercial credit where a lender sets aside a certain amount of funds for your business to use as they’re needed. It has similarities with a credit card or a line of business credit, with some of the same advantages and disadvantages. A business overdraft is attached to an existing financial account, such as a savings or transaction account with a bank. Once it’s set up and approved, it allows your business to continue withdrawing money from your account even after the balance has reached zero.
A business overdraft facility can potentially offer a substantial amount of funds. The limit on any given account will be set by the lender while you’re applying for the overdraft facility, but it’s possible for an unsecured business overdraft to offer in the area of $100,000. If you’re willing and able to offer security on the overdraft facility, though, this amount can be much larger – potentially into the millions. These are different from how business loans work, which involve granting you a lump sum and having you repay it over a set period in instalments.
How do I compare a business overdraft facility to another?
When it comes to comparing one overdraft against another, there are a few things to weigh up. For starters, as a business overdraft is a facility attached to an existing account, there’s obviously a convenience factor to setting up the overdraft on the account you’re already using. However, if you’re looking to set up a brand-new account for the overdraft facility, or you’re willing to change account, there are several factors that are worth considering as you compare your options.
- Secured or unsecured – Does the overdraft require securing, or is an unsecured overdraft an option? Some lenders will only offer a secured overdraft if you’re not an existing customer, for example.
- Interest rate – The interest rate can make a big difference to what you pay on a business overdraft – especially if you need to use a large amount of credit or you’re not able to clear the debt promptly. Be careful, though: the advertised rate that lenders show on their website might not be the exact interest rate you’re offered on an overdraft, as it’s intended as a reference only. Providing security for your loan will lower your rate.
- Credit limit – Different lenders may offer different credit limits on an overdraft. The financial situation of your business can influence this and secured credit lines will normally offer much higher credit limits.
- Fees – Different lenders charge very different fees. Some might have no setup cost, but charge a higher annual fee (which is often calculated daily, despite the name). Others might have a higher application fee but charge less per year. Also, some might not openly advertise some fees, simply saying you can find the cost “on application”.
Types of business loan
The most common type of business finance, unsecured loans enable businesses to access the funds they need without attaching an asset to the loan as security. Some lenders may allow you to borrow up to $500,000 and, because there's no collateral, offer same-day approval.
If your business already owns valuable assets, such as property or expensive equipment, you may choose a secured business loan instead. These loans may increase your borrowing power beyond what an unsecured loan can offer and, crucially, typically come with lower interest rates.
Business loans don't always have to be worth hundreds of thousands. If you're operating a small business and need a boost to help you keep on top of your expenses or expand your company, you may be able to take out a loan starting from as little as $5,000 and unlock further capital.
Just because you don't have all the required documents for a standard business loan doesn't mean you're out of options. Low doc finance enables you to use alternative documentation, such as other business financials, in the application process to access the funds you need.
A commercial line of credit allows you to draw from your loan account whenever your business needs access to their funds, instead of managing a lump sum and repaying it like a regular loan. This can add flexibility to your finance arrangement, providing money when you need it.
Invoice finance presents another option to business operators looking to free up cash through outstanding invoices yet to be paid by their customers. Your invoice finance can either be invoice discounting or factoring, which present different options when it comes to your invoices.
A common reason for seeking out a loan is to purchase commercial equipment. You can do this either with an unsecured arrangement or one with the equipment itself as collateral, with the latter potentially increasing your borrowing power and lowering your interest rate.
With this finance, when your business purchases product, your supplier provides an invoice which you send to your financier and pledge to repay by a set date. From there, your supplier sells the invoice to your financier at a discounted rate, while you repay the full amount to your financier.
Under an inventory finance agreement, your lender pays your supplier directly for inventory, which allows it to be signed off and sent to you. From there, you can pay off your debt within a pre-determined period to your lender, which may be longer than the regular debtor period.
An overdraft facility is attached to an existing financial account belonging to your business, such as a transaction or savings account, and enables you to borrow up to a set limit after the account’s balance reaches zero. These overdrafts are repaid with interest, but only on what you use.
You may simply be in a position where your business needs a boost to its cash flow. If this is the case, there’s a range of stop-gap solutions which may be suitable for your situation, from standard unsecured loans to specialist cash flow loans, invoice finance or even an overdraft.
Why compare business loans through Savvy?
Pros & cons of an overdraft facility
Simple application process
The application process for an overdraft facility is similar to that of a loan application, but can often be completed more quickly. For many lenders, it’s simply a matter of logging onto their website and applying through your account. Of course, if you don’t have a business account with your lender of choice, you’ll need to open one.
An overdraft facility is a very flexible way to access money. You can draw on your credit at any time, without any additional approval needed. You can also repay the money as funds are available, making an overdraft facility very handy if your cash flow fluctuates.
Can be used for almost anything
There are very few restrictions on what you can use the money from a business overdraft for. While you need to provide a lender with details of exactly what you intend to use loan funds for, there’s no such restriction on an overdraft facility, so it can be used on bills, wages, equipment upgrades, special events or expenses to boost staff morale. You do need to use it for your business and not for personal reasons, though, otherwise you’re breaking the terms of your overdraft agreement.
Can be cancelled at any time
Trying to settle a loan early can be something of an arduous process. An overdraft facility can be shut down at any time – provided you don’t currently have anything owing on the account.
Significant fees for going over the limit
If you spend more than your limit on an overdraft facility, you can potentially be hit with some pretty hefty fees, so it’s a good idea to keep a careful eye on your expenses and your account balance once you’ve dipped into your credit.
Higher interest for long term debt
While you only pay interest on the money currently in use, the interest rate on an overdraft facility is generally quite high. This means that if you find yourself caught out by debt and struggling to repay the overdraft, you’ll be paying more significant interest on that debt.
More impact on credit score
As mentioned, a business overdraft facility is a kind of credit. As such, how you use it has a significant impact on your business’ credit rating. This means you might not want to make your limit on the overdraft too high. It’s also wise not to use more than a third of the credit you have available.
Temptation to overspend
Sometimes having the option of going easily into debt can be an unhelpful temptation. While running out of money can force a business to make necessary hard choices or find alternative sources of funding, having the option to easily borrow money can potentially land you in substantial debt by overspending a little at a time. It can also give you a false sense of security about your financial situation.
Frequently asked questions about overdraft facilities
Helpful business loan guides
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